Bidding Wars: the economic inefficiency of real estate
Wednesday Mar 03rd, 2021
At the risk of sounding melodramatic, I honestly believe that bidding wars are among the greatest economic inefficiencies ever produced by the real estate market.
In 2017, we saw a pretty wild market, with real-time price discovery being the greatest challenge of buyers, sellers, and realtors alike. As a result, we saw the arbitrary underpricing of properties that led to even more arbitrary firm offers being submitted. Ultimately, this created risk for buyers, sellers, and lenders as we approached a massive correction in 17Q2. During that time, it was not uncommon to see buyers walk away from deals that lost market value prior to closing. It was equally common to see lenders reject the deals based on the comparative market appraisals being unsubstantiated. This phenomena was especially true for properties that sold over 110% of asking price.
It appears we learned only one thing from 2017: that if you price a property well below market value, you don't really have to do anything to get offers.
This strategy has become so common, in fact, that it's even becoming apparent in the data for two of the GTA's hottest real estate markets:
In a rising price environment, you're seeing asking prices actually decrease. Asking prices have been effectively replaced with "starting prices" in all too many cases. The challenge is that even as a starting price, the seller's expected price is absolutely arbitrary. The market's willingness to pay is equally arbitrary, due to the closed-bid process used by our market.
I've had some good exchanges on Twitter about this topic. It's led me to evaluate my position on the matter. In many cases, people are applying the caveat emptor philosophy. Why don't buyers give up? Why don't they adapt their search to account for the difference?
Honestly, they're great questions - and the answer is just as simple as the their recommendations. Properties are still selling near asking price in a variety of price ranges. Given that information, buyers still feel compelled to look at everything that appears affordable - as is their right.
So, what's the problem here?
The problem is that during that process, hundreds of hours are being wasted on viewings that don't ultimately translate to a sale. I'm not a rocket surgeon, but I'm pretty sure that would qualify as economically inefficient. I'm also not a philospher, but I suspect this may go beyond the relative moral violation of covid guidelines, while pricing to attract hundreds of property tours. I'm not remotely qualified to talk about moral relativism. So instead, let's try to quantify the economic inefficiency of one underpriced listing:
Let's make a couple of conservative assumptions here:
- If a property sells over 110%, it likely has about 10+ offers.
- If a property has 10+ offers, it likely has had 70+ viewings
- A viewing has an average of 3 people present (1 agent, 2 buyers)
- Each viewing is about an hour in total length (including driving time)
- At a minimum, people buying homes today would earn a wage of about $30/hr.
- Average real estate agents likely make around the same, at about $30/hr.
In order for one person to purchase an underpriced, over-toured listing, it costs the economy a minimum of $6,300. Not a big deal, right?
Let's think about offers now. If we just assume that the offer process takes 10 of the buyer/agent teams one hour per person - you can include another $900 of inefficiency.
Still not a big deal, right?
I'd generally agree on an individual basis. The problem is that this is not happening on an individual basis - it's systemic.
In York Region alone, the share of properties that sold over asking price increased from 42% in the first week of the year to 76% in the most recent week.
In Durham Region, the same metric increased from 64% in the first week of the year to 89% in the most recent week.
That's just the buyer's issue though, right?
It's not like sellers aren't price discovering, right?
It's not like the market would deliberately underprice listings to simplify the valuation and marketing of their property and defer that accountability to the buyer... ... ... right?
And so we've arrived at where we are today. We are literally watching listing prices fall while sale prices rise. What's worse, the total percentage over-asking is still increasing, while the listing prices decrease. The idea of an "asking price" has been all but replaced by a "starting price". We've turned our real estate market into a silent auction. Have fun, folks.
In York Region alone, 1,138 listings have sold over 110% so far in 2021 (headline chart).
If you use our prior example of a minimum $6,300 net time cost and $900 net offer time cost per 110% listing:
So far, underpricing has cost York Region homebuyers a minimum of $8,193,600 in wasted hours.
Keep in mind, this is using an average hourly wage of $30. I'd guess that the average hourly wage of purchasers in the GTA is well above that.
Since the beginning of the year, 3,874 GTA listings have sold over 110% of asking price.
This has cost $8,135,400 in wage-time spent on viewings.
It has added a likely unnecessary 267,306 GTA home tours during a global pandemic.
The Closed Bid
I got a lot of good feedback from this article on LinkedIn and Twtter, and I figured it was worth adding a discussion here. I ignorantly presumed that it was evident that the root cause of this inefficiency is the closed-bid process used by Canadian real estate. To my knowledge - this process exists because The Privacy Act protects the contents of individuals' contracts as private information.
The closed bid isn't directly responsible for the inefficiency. The real estate brokerage is built on asymmetrical information - and a closed bid protects that. This asymmetry is being exploited by the market to create the inefficiency, causing more viewings and confusion than is necessary.
This exacerbates the arbitrary nature of pricing in the market - a vagueness which originates with the closed bid.
Yeah, I'm obviously sensationalizing this whole phenomena a little bit, but I think it's worth being aware of for one specific reason:
In OREA's code of ethics, there are a few references that could make sense here:
4. A registrant shall promote and protect the best interests of the registrant’s clients. O. Reg. 580/05, s. 4.
Does getting 75% more viewing activity during a global pandemic accomplish this goal - especially when >50% of viewings are by hopefully buyers who can't afford the real expected price?
Conscientious and competent service, etc.
5. A registrant shall provide conscientious service to the registrant’s clients and customers and shall demonstrate reasonable knowledge, skill, judgment and competence in providing those services. O. Reg. 580/05, s. 5.
37. (1) A registrant shall not knowingly make an inaccurate representation in respect of a trade in real estate. O. Reg. 580/05, s. 37 (1).
3.2 A REALTOR® shall not intentionally mislead anyone as to any matters pertaining to a property.
3.9 “Dealing fairly” means acting honestly and professionally. The obligation to deal fairly does not in any way reduce a REALTOR®’s obligation to fulfill his or her fiduciary duties to a Client and follow the Client’s lawful instructions.
Morals vs. Economics
I guess I've managed to digress this internal dialogue from an economic inefficiency into a moral quandary. And for that reason, I'm out.
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